A foreclosure is a business transaction by which a bank becomes a property owner after having been the mortgage holder for the property. All business transactions are recorded accordingly in accounting books, and a foreclosure requires certain accounting entries to reflect the change in a bank’s asset holdings from loan to property. A foreclosure also involves other accounting entries to account for any foreclosure impairment while a bank holds the foreclosed asset and the sale of the foreclosed asset at last.
When a bank forecloses on a property that is the collateral of its loan, it effectively acquires the foreclosed asset and releases the borrower from his payment obligation by writing off the defaulted loan. In general, the accounting entries would record a debit to foreclosed asset and a credit to the loan outstanding. If the fair market value of the foreclosed assets is higher or lower than the amount of loan outstanding at the time of the foreclosure, the foreclosure generates a gain or loss, recorded as a credit or debit, respectively. Otherwise, the foreclosure fully satisfies the loan without any gain or loss.
A foreclosed asset may be impaired in value while being held and must be re-evaluated on any decrease in the foreclosed asset’s fair market value over time. An impairment charge is loss that goes to the income statement. Accounting entries would debit loss on impairment and credit the related foreclosed asset. The fair value of a foreclosed asset may also increase later, and, thus, a gain should be recorded as a credit. However, the basis of a foreclosed asset should never exceed its acquisition basis.
Foreclosure disposition refers to the sale of a foreclosed asset. After the sale, the bank that owns the foreclosed asset will remove the property from its balance sheet and record the sale proceeds, as well as any gains and losses. Accounting entries would debit cash and any loss and credit the related foreclosed asset and any gain. However, to be considered as a sale, the buyer’s investment must be adequate to demonstrate a commitment to pay for the property.
The sale of a foreclosed asset may also involve a seller financing in which the buyer provides only a certain amount of down payment at the time of the transaction. With seller financing, a bank that sells the foreclosed asset would record a debit to loan receivable as an asset on its balance sheet. Any down payment is also debited, but gains or losses may not be fully recognized at the time of the sale. The bank will recognize only a partial gain or loss in proportion to the cash received thus far and record the balance of the gain or loss as deferred.
An investment and research professional, Jay Way started writing financial articles for Web content providers in 2007. He has written for goldprice.org, shareguides.co.uk and upskilled.com.au. Way holds a Master of Business Administration in finance from Central Michigan University and a Master of Accountancy from Golden Gate University in San Francisco.